Teach kids to pay themselves first

Healthy finances - April 2006

Susan Beacham

9/10/09 1:35 PM

In last month’s column, I talked about how important it is for parents to model the kind of money management behavior we want our children to practice. As experienced parents, we already know that as far as our kids are concerned, our talk is cheap. Our kids watch us and get their education from us by observing our behavior. What we do, they will do. OK, not everything right away, but most things eventually.

So, to teach our children about how to save money, we need to demonstrate that behavior and save money. As a nation, our track record on that score is not good.

In fact, reports on adult savings behavior are downright scary. In a recent study by the Consumer Federation of America and the Financial Planning Association, one-fifth of Americans said they think winning the lottery represents the most practical way to accumulate several hundred thousand dollars. According to the Commerce Department, the savings rate for 2005 was the lowest since the Great Depression, negative 0.5 percent. That means that last year, many people spent more money than they brought home in their paychecks.

A simple fix

This kind of behavior is resulting in generations of kids that fail in adult life not because they are not smart enough to get a great job, but because they don’t know how to be smart about the money that job pays them every two weeks. We as their parents can fix that. And it’s simple.

Every time you get paid, let your kids know that you are taking a portion of that paycheck and putting it into a savings account. Some of that savings may get invested later, but for now, let your children know that after you get paid by your company, you first pay yourself before any money gets spent.

Lots of kids will glaze during this discussion. Grab their attention back with this exercise:

Agree to record for one week what you (and your child if he’s old enough to spend money without you) spend on a daily basis. Then, at the end of the day, talk about what portion of the money was spent on "I want" vs. "I need." "I wants" are things such as snack food or a small toy for the kids, coffee out or a snack on the run for parents.

Chances are you will be able to identify $4 each day that was spent on the "I wants."

Miracle of compounding

With that $4 of "I want" money, pose this question to your child: At age 12, you decide not to buy soda or snacks. Instead, you save the $4 a day and put it into a savings vehicle, such as a long-term CD that pays 5 percent annual interest, and leave it alone. At age 67, your savings totals: (a) $1,159, (b) $25,355, (c) $80,352 or (d) $427,025.

Answer (drum roll please): (d) $427,025.

Now here is the truly remarkable part: only $80,352 is from the daily $4 deposits. The remaining $346,673 is interest.

How does that happen? Compound interest. Physicist Albert Einstein called compound interest the most powerful force in the universe. It’s called compound interest because it is paid on the principal and the accumulated interest, so your money grows faster. (A neat compound interest calculator can be found online at http://math.about.com/library/blcompoundinterest.htm.)

Children of all ages need a savings account that pays them interest. Making deposits themselves in their own savings account (and a few withdrawals) will help set the savings behavior for them.

Open the savings account with your child in tow. You will need her birth certificate and Social Security number to open the account. Community banks are good for this kind of account, since they generally offer minor accounts with small minimum deposit requirements.

Once you open the account, talk to your child about a savings goal. This should be a short-term goal—something they might want one year from today. The goal should cost less than $100 for the youngest and less than $1,000 for older kids.

Once the account is open and the goal is set, help your child find ways to earn money. Babysitting, shoveling, raking leaves and cleaning the kitchen after dinner all make life easier on us and provide some working capital for kids.

Unfortunately, passbook savings accounts these days carry very small interest rates, which can make it tough for kids to appreciate that miracle of compounding. So consider helping motivate your child by matching her savings.

And, by all means, take your child with you each time you make a deposit. When they are old enough, teach them how to fill out deposit and withdrawal slips. Set a schedule for making deposits, but go at least once a month.

Next month: spend.

Editor’s note: This is the third in a series of six columns to help kids get smart about money.

Susan Beacham is the founder and CEO of Money Savvy Generation, a financial education company that provides innovative products and services to help parents and educators teach children the skills of basic personal finance, www.MoneySavvyGeneration.com. E-mail her at [email protected]